Wednesday, March 2, 2016

Unravelling Some Occult Mysteries of the Heterodox

Noah Smith has a new post, "Occult Mysteries of the Heterodox," criticizing Heterodox economists who seem unable to provide a simple explanation of their new, and supposedly superior, methodologies. “They show every indication of having no new methodology whatsoever.”  And later, in a "tweetstorm," Noah accuses Post Keynesians, in particular, of only being interested in methodologies that yield their favored conclusions.

In contrast to the the PKs, who offer nothing but "criticism," Noah points to “the Solow Growth model” as a useful and accessible scheme of analysis.  I’ll get to alternatives in a moment, but I think Noah is much too blasé about the importance of “criticism,” and his reference to “the Solow Growth model” provides a good illustration of the problem.

Leaving aside the Cambridge (UK) critique of aggregate production functions (the mere mention of which brands one a hopeless ideologue), here’s a brief paper by Jesus Felipe and Franklin M. Fisher, who carefully explain the conceptual difficulties with aggregate production functions and then patiently respond to all the justifications offered by those who still use these models despite their drawbacks.  

Some defenders of mainstream economics brush off critics, claiming they just don't know the math.  Well, Kenneth Arrow and Robert Solow, who do know the math, haven't been impressed by the modeling inspired by Lucas and Sargent.  Perhaps Stephen Williamson is right to dismiss these critics because they “fail to understand the power of the work they did,” but this claim requires an argument that addresses the actual criticisms offered by Arrow and Solow, not to mention those of Frank Hahn, Franklin M. Fisher, and several other first-class economists.

Noah is mistaken when he says PKs simply favor the methods that will produce their favorite conclusions.  I think, in opposition to Noah's view, that PK approaches and methods arise from their criticisms of orthodoxy.  

For brevity’s sake, I’m going to mention one assumption widely held among PKs, which is that neither market participants nor economists “know the data-generating process.”  Awhile ago, Brad DeLong, commenting on a Lars P. Syll post, granted that there may be something worthwhile in this point of view, but asked, “what kind of economic arguments do we make” once this assumption is accepted?

Here’s a short list of the sort of practical ramifications of assuming that neither market participants nor economists know "the data-generating process."

1. First, let me note that our ignorance is manifest in the disagreement among economists about the causes of the Financial Crisis and the Great Recession, the effects of QE on interest rates and inflation, etc.  Such disagreement gives rise to many, often inconsistent, beliefs about the economy, and this diversity of beliefs must be taken into account in thinking about the economy.  Isn't it worth modeling economies in which market participants hold conflicting views of the future?  Wouldn't such an economy behave differently from one in which everyone shares the same rational expectations?  Mordecai Kurz has done interesting work in the area. And agent-based modeling (Santa Fe style) may prove useful in thinking about interactions among agents with different “views of the world.”

2. If you don’t know how “the data-generating process” works, or if there is no such thing, then history, path dependence, and hysteresis should play a larger role in thinking about the economy.

3. Since agents don't possess a complete list of states and their probabilities of occurrence, many people rely on verbal models, narratives, and stories to guide their economic decision making, and the role these informal “models” deserve examination.  See some of Robert Shiller’s recent work as well as this paper, which finds the EMH wanting once "the news" is taken into account.

4. Disequilibrium micro foundations (and mutually inconsistent expectations) attracted a lot of first-class economists from the mid-1950s until the early 2000s, including Hicks, Debreu, Hahn, Samuelson, Clower, Leijonhufvud, Negishi, and several others.  Arrow, himself, thought of the macroeconomy as "a disequilibrium phenomenon," and this vantage point is worth another look.  R. Backhouse and M. Boianovsky wrote a good book on the subject.

It may be objected that the economists mentioned above are not Post Keynesians, or at least do not identify themselves as such.  I concede this point because I’m concerned with methods and approaches that avoid some of shortcomings of mainstream thinking, rather than with the purity of Post-Keynesian economies.

Monday, January 11, 2016

What's at the Bottom of Ted Cruz's Fantasy Spanking of Hilary Clinton

Ted Cruz seems like a rational fellow, but David Brooks claims that Cruz’s world is “combative,” “angry,” and “apocalyptic,” his speeches full of “dark and satanic tones.” I rarely agree with Brooks, but there is something “dark” in Cruz's telling voters to “spank” Hilary Clinton like Cruz spanks his 5-year old daughter.

On the surface, spanking is just a way to discourage bad behavior. But beneath the surface, after the child’s buttocks have been exposed to the same parent who teaches “modesty,” and the shame is comingled with the pain, we get a glimpse of the erotic origins of masochism and of adult bullies and abusers who reenact their childhood punishments by becoming “punishers” themselves.  

Sometimes when children are spanked, they don't respond at all.  Their facial expression exhibits nothing, no feeling whatsoever.  I've never seen Cruz's daughter's face during the spankings Cruz finds so pleasing, but I have seen the out-takes of some Cruz-for-President ads involving his family, and their interaction doesn't contradict David Brooks' portrait of Cruz as a man whose words are imbued with "dark and satanic tones."

Tuesday, September 29, 2015

Rational Expectations and the Microfoundations of Autonomy

One aspect of modern economies that deserves more attention is the variety of beliefs that inform the decision making of households, firms, and governments.  Every asset market includes bulls who believe prices will rise and bears who believe they will fall.  Central banks and national governments draw on diverse macroeconomic models in their policy making, which is evident in the conflicting predictions about the effects of quantitative easing.  And Nobel Prizes in economics have been awarded to economists advancing sharply divergent theories, the most recent example being the 2013 Prizes awarded to Eugene Fama and Robert Shiller.

On its face this multiplicity of views seems incompatible with the hypothesis of rational expectations.  If all agents have access to the same information and the same (correct) model of the economy, then, instead of a multiplicity of expectations, we would see a uniformity of expectations.  Some of this real-world diversity of expectations can, of course, be explained by “information partitions” in which market participants have access to different pieces of the “information pie.”  The force of this explanation is diminished, however, by the broad dissemination of government statistics and the widespread use of information technology to organize and analyze this data.  Moreover, economists with access to the same data and information processing capabilities nevertheless produce conflicting explanations of historical trends and events, divergent forecasts of future trends, and opposing predictions about the effects of various monetary and fiscal policies.

This multiplicity of outlooks, whether in the form of theories, models, beliefs, or expectations, calls into question the usefulness of the postulate that economies are always in equilibrium.  Even if a rational expectations, representative agent, model could be calibrated to track some time series of economic data, it could hardly explain the obvious presence of agents with diverse and, often conflicting, views.  Furthermore, if market participants are acting on the basis of inconsistent expectations, then at least some of these expectations will disappointed and some plans will have to be revised.  To insist on characterizing an economy in which the participants are planning to buy and sell at different prices as being in equilibrium is simply to insist on a stipulated definition come what may. 

In their Anti-Keynesian manifesto, Lucas and Sargent (1979) criticize the lack of microfoundations in the Keynesian models that were developed in the 1950s, 60s, and early 70s.  Many reasons have been offered in defense of microfoundations as a necessary feature of a good macro model, including an implicit appeal to the familiar notion of autonomous agents who form and act upon their own plans and forecasts.  Thus, Lucas and Sargent chastise “economists who ten years ago championed Keynesian fiscal policy as an alternative to inefficient direct controls [now] increasingly favor the latter as ‘supplements’ to Keynesian policy” (original stress).  But it’s the gloss they add to their argument that’s most revealing.  Mocking these old fashioned Keynesians they write, “The idea seems to be that if people refuse to obey the equations we have fit to their past behavior, we can pass laws to make them do so” (original stress).  Free and independent agents keep changing their minds in response to new information, so their “past behavior” is, at best, an imperfect guide to their future behavior.

A closer look reveals that the New Classical demand for microfoundations straddles two incompatible ideas.  On the one hand, Lucas and Sargent insist on microfoundations because they believe economic outcomes depend on the rational choices of individuals rather than on the behavior of aggregates.  What is “the Lucas critique” if not a vigorous statement of this point?  On the other hand, genuinely autonomous agents, who choose their own objectives and the means of achieving them, will often hold different views about the future.  Indeed, this a reasonably good description of what happens in societies when the unquestioned guideposts of custom and tradition give way to some measure of individualism and self-determination.  Thus, while the demand for microfoundations appeals to the idea of independent agents constructing their own action-guiding scenarios, the variety of beliefs that emerge from, and guide the actions of, these agents is suppressed by the premise of rational expectations.  If we really want macroeconomic models that are consistent with free and independent agency, then we need a new “microfoundations of autonomy.”  I’ll return to this topic in a future post.

Wednesday, August 5, 2015

In Defense of Robert Solow’s “Sarcasm”

Paul Krugman writes, “Paul Romer continues his discussion of the wrong turn of freshwater economics, responding in part to my own entry, and makes a surprising suggestion — that Lucas and his followers were driven into their adversarial style by Robert Solow’s sarcasm.”

No examples of Solow’s sarcasm are given by Krugman or Romer, but perhaps the following qualifies in their view:

“Suppose someone sits down where you are sitting right now and announces to me that he is Napoleon Bonaparte. The last thing I want to do with him is to get involved in a technical discussion of cavalry tactics at the battle of Austerlitz. If I do that, I’m getting tacitly drawn into the game that he is Napoleon. Now, Bob Lucas and Tom Sargent like nothing better than to get drawn into technical discussions, because then you have tacitly gone along with their fundamental assumptions; your attention is attracted away from the basic weakness of the whole story. Since I find that fundamental framework ludicrous, I respond by treating it as ludicrous – that is, by laughing at it – so as not to fall into the trap of taking it seriously and passing on to matters of technique.”

This isn’t sarcasm.  It’s a refusal to enter into a discussion with economists who refuse to discuss their own fundamental assumptions, viz. the “classical postulates” of rational choice and market clearing.  The analogy that comes to my mind are the libertarian arguments of Robert Nozick.  If you’re drawn into a debate over whether certain policies violate someone’s property rights, you’re apt to forget that it’s Nozick’s conception of property rights, itself, which is in need of justification.

Solow isn’t the only first-class economist who has found New Classical economics not worth delving into.  Although Lucas looks to the Arrow-Debreu model and its date- and state-dependent commodities as pillars supporting his own modeling, Arrow, himself, has rejected the notion that the macroeconomy is always in equilibrium and has mocked New Classical explanations of the Great Depression.  And Frank Hahn, who wrote an important book with Arrow, regarded modern general equilibrium theory, not as a framework for modeling the macroeconomy, but as a “list” of the far-fetched conditions required to rule out “Keynesian problems.”

I find New Classical Economics very clever and kind of interesting, but the scientism and “methodological arrogance” exhibited by some of its proponents is repellent to me.